Use strategies to counter low interest rates

Q: I need income from my portfolio, but interest rates are so low, what can I do? Eric — Santa Barbara

A: The Federal Reserve has maintained a "zero interest" rate policy for some time in an effort to stimulate the economy. On top of that, there has been a big rush by investors into bonds, and by the nature of how those work, as prices increase, yields decrease. When you couple those together, the result has been historically low interest rates for those who can qualify for a home loan, but money market accounts, CDs, government bonds and the like pay anemic rates.

The critical interest rate to follow is the 10-year Treasury (often referenced as the "risk-free" rate, hovering around 2.5 to 3 percent). Once you know this number, you can determine the perceived "fair value" of virtually all other investments. For example, other bonds, such as corporate debts and municipals (tax-free), trade on a "spread" in relation to Treasury bonds. Since government debt is "guaranteed" and considered the safest investment in the world, any normal person would require additional interest from a competing investment. The safer the bond, the lower the spread, and the more paid, the riskier the investment.

If you look historically at "spreads," the corporate bond world has paid 1 percent to 7 percent higher interest than corresponding government debt. But your guess is right: the 7 percent difference represents the really risky stuff (junk) and the 1 percent represents the "safest" of corporations, with the rest floating in the middle.

Regardless, interest rates are low, but inflation is nonexistent as well, so what should you consider?

For wealth management, you may want to consider reducing or refinancing high-interest debt. You may also have to cut your lifestyle expenses unless you are willing to invade principal.

For tax management, the municipal bond market is a little of an anomaly to the above. Because you don't pay taxes on the interest earned from these bonds, they typically yield less than their Treasury counterparts. With the uncertainty of state budgets, however, a lot of these bonds are paying more (but you assume more risk).

For investment management, low interest rates typically make stocks more attractive. It also allows corporations to finance activities cheaply. Although unemployment remains high and a stalling economy overshadows everything, there are some attractive dividend yields being paid, levels in comparison to Treasuries that we have not seen for a long time.

Risk management is pretty simple: Reference the risk-free rate and then consider alternatives. Any higher return you receive is coupled with some kind of real or perceived risk. Be careful of "stretching" for yield, pay attention to maturity length and understand the quality.

— Stark and Streeter are co-founders of Mission Wealth Management LLC in Santa Barbara. Questions can be submitted to asksb@missionwealth.com.